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529 College Savings Plans
The Investment Program
Contributions to the Plan
Funds From Other Plans
Powers of the Account Holder
The Account's Beneficiary
Federal Income Tax Considerations
State Income Tax Considerations
In Conclusion
In 1996, Congress established an effective and flexible way
to set aside money for college expenses. The plan allows individuals
to create a special type of savings fund for the educational
expenses of children, grandchildren or others, and fund it with
up to $55,000 free of any gift
tax.
This account is commonly referred to by the Internal Revenue
Code under which it was established, and is called a "529
plan" or "529 College Savings Plan". The funds
in the account are permitted to grow tax-free, and the individual
who establishes the plan is allowed to control the distribution
of the plan's funds and to allow all the funds in the account,
including both the principal amount and any earnings, to be
withdrawn for any post-secondary educational costs free of any
income tax.
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The Investment Program
The Internal Revenue Service allows each state to sponsor
one plan of this type, per state. Most states offer such
a plan, and anyone desiring to contribute to such a plan
may contribute in any state that provides them, not just
in the state in which the person resides. An account in
one state may be transferred to another state that also
offers these types of plans.
A person contributing to a plan usually has several choices
for investing the funds. The state offering the fund controls
the choices, which can vary considerably, but large investment
firms such as Vanguard and T. Rowe Price are frequently
included and involved.
| The contributor to the plan may only
make cash contributions and cannot directly manage
how the funds are invested, nor can the funds be
used as collateral or security for any type of loan.
The contributor may select investment choices and
change them annually if the plan permits this. |
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The law permits fees to be charged in association with the plan,
and annual fees for both the account's maintenance and administration
are permitted along with investment management fees charged
by the fund manager.
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Contributions to the Plan
Contributions can be made to anyone's account, by anyone
who is at least eighteen years old and is a United States
citizen or permanent US resident. While there are no
limits on the contributor's income, there are also no
income tax benefits for making the contribution. Contributions
are permitted to an account for any specific beneficiary
until the account has a value of $250,000, although
the account can exceed that amount by subsequent growth
or income.
A contributor may deposit up to $55,000 at one time for one
beneficiary and remain with the allowable gift
tax limit. The federal maximum gift amount is $11,000 per
year, per individual recipient, and this gift to the 529 plan
is considered to be a gift of that amount for the current and
the next four years. IFor this five year period, the contributor
may not make any other gifts to the plan's beneficiary that
are exempt from taxes. f the contributor dies before the five
years are over, his or her estate will include the balance of
the remaining contribution for estate tax purposes for the estate.
To illustrate the process, John Smith made a $55,000 to
a 529 plan for his son in 2005, and then dies the following
year. Since his $55,000 gift is considered to be his annual
gift of $11,000 for 2005 through 2009, $22,000 of his
contribution is considered exempt. This figure represents
his $11,000 contribution for both 2005 and the year he
died, 2006. The remaining $33,000 is included in his taxable
estate for estate tax purposes, and all earnings and appreciation
of the 529 plan are ignored. Had John survived through
2009, the entire $55,000 would have been excluded from
his taxable estate.
A husband and wife can each contribute this $55,000 to
as many children or grandchildren as they can afford.
If they have enough money, they can contribute, for example,
$550,000 between them to the accounts of five children
or grandchildren. If they survive the five years following
this contribution, they've reduced the value of their
taxable estate by over half a million dollars.
While the $55,000 is the maximum, most plans require a minimum
initial contribution of between two and five thousand dollars.
As long as the fund remains under $250,000 maximum, additional
amounts may be deposited at any time as long as the plan permits
them.
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Funds From Other Plans
Funds in one plan may be transferred to another qualified 529
plan at any time. Funds in a Uniform Gift
to Minors Account or Uniform Transfer to Minors Account
may also be transferred, although since the funds in those accounts
may be considered as gifts, the advice of a qualified accountant
is advisable.
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Powers of the Account Holder
The person who contributes to the account is considered its
owner and is in control of directing payments from the account
to the designated beneficiary. The plan under which the account
is governed does not permit any automatic payments, nor can
any be made from a request by the beneficiary. If the person
who owns the account dies, a named successor takes over, but
if no one is named, then the beneficiary may select one. The
beneficiary, however, may not name him or herself as the successor
account owner.
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The Account's Beneficiary
The beneficiary of a 529 College Saving Plan can be any
permanent United States resident or citizen. The plan
does not impose any age limitations, so adults as well
as children can be the beneficiary of the account, with
the funds used for adult education.
| The funds in the plan may be used to pay for tuition,
books, supplies, and equipment required to either
enroll or attend any qualified educational institution.
The funds can be used for room and board as well,
as long as the student is attending at least half
time. The owner or contributor of the account can
change the beneficiary whenever he or she wishes
as long as the new beneficiary is related to the
old one by blood or marriage. |
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If the beneficiary dies before the funds are depleted,
the contributor may withdraw them without penalty, but
any earnings are subject to income tax.
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Federal Income Tax Considerations
The principal amount deposited to the account is never
subject to any federal income tax when the funds are distributed,
but any earnings or appreciation are. Funds maintained
in the account, however, can grow without any tax concerns.
The part of any distribution that can be considered
as earnings is taxed to the beneficiary as ordinary
income unless it is used for a college expense as listed
earlier. If the distribution is not used for one of
the qualified educational expenses, the portion of the
distribution that represents earnings is taxed to the
beneficiary as ordinary income and is also subject to
a 10% penalty. If the beneficiary is deceased or disabled,
the penalty can be waived, and it can also be waived
if the beneficiary receives a scholarship equal to the
amount of the withdrawal.
If the owner of the account closes it and takes the money back,
which he or she is allowed to do, the earnings are subject to
income tax and a penalty of 10% will be imposed on them.
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State Income Tax Considerations
Distributions and benefits of a plan are taxed differently
by different states. Some states do not tax the benefits
if they are used for a qualified educational expense
while others do, and some states allow an income tax
deduction for funds contributed to the plan, but others
do not.
California state law does not consider contributions to 529
plans to be deductible for income tax purposes and taxes the
earnings as ordinary income when they are withdrawn.
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In Conclusion
A 529 College Savings Plan is a very flexible and effective
way for someone to set aside a large portion of his or her estate
for a relative's future educational expenses. The advantages
and disadvantages of contributing to such a plan should be discussed
with your accountant and estate
planning attorney before the plan is initiated.
THE MAMOLA LAW FIRM, APC is conveniently located throughout Orange County. For additional information, please contact us at (949) 333-6543.
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